Ambarella, Inc. (AMBA) develops semiconductor processing solutions for video that enable high-definition video capture, sharing, and display. The company designs fully integrated high-definition video processing, image sensor processing, audio processing, and system functions onto a single chip for delivering high video and image quality, differentiated functionality, and low power consumption. Its solutions consumer pocket video cameras, wearable sport cameras, Internet Protocol, security cameras, and ruggedized outdoor cameras, as well as broadcast encoding and IP video delivery applications. Ambarella's technology is also used in television broadcasting with TV programs being transmitted worldwide using the company's compression chips. These chips allow cameras to record in Ultra High Definition (UHD) resolution of up to 4K. This is more than four times greater resolution than the current Full HD standard. Ambarella, Inc. was founded in 2004 and is headquartered in Santa Clara, California.
The Company had its IPO last week and after initial pricing expectations of $9-11 the stock priced 6 million shares at $6 share. The poor pricing is a head scratcher as the company has been profitable every quarter since 2010, generates significant free cash flow, is growing revenue, has high margins, has no debt and holds a huge amount of cash. Additionally, it is backed by three private equity firms and only one firm sold any shares in the IPO and they sold just a fraction of the shares they hold. Management and executives sold basically none of their shares in the offering. These are both signs of confidence and strong handed investors in this Company as they are not simply looking to "cash in" on the IPO. After the IPO, management and executives will own over 36% of the Company and the private equity firms will hold over 33% (approximately 70% collectively).
Let's start with the capital structure and enterprise value of the business. It is a microcap stock as the Company has around 26 million shares outstanding immediately after the IPO (with only a 6 million share float) and the price is around $6 a share currently giving the Company a market cap of only around $160 million. However, the Company has approximately $90 million of cash on the balance sheet and no debt after the IPO. Therefore, the market is only valuing the equity (and in this case the enterprise value) at around $70 million. I will explain why I think this valuation makes the stock a buy with material upside and a rather limited downside from this price.
I will start by using some valuation ratios to show why I think this is undervalued and then go into some qualitative reasons why I think this is a buy and some risks I see in the business. The Company is on pace for around about $108 million in revenues, $18 million in EBITDA and $15 million in net income this year if you annualize the results from the first 6 months. The upcoming third quarter is the best quarter of the year for the Company so these numbers may be low. However, let's just annualize them as I have here. Therefore, if those results come through the valuation multiples are amazingly low:
Enterprise Value / Revenue = $70 million / $108 million = 0.65x
Enterprise Value / EBITDA = $70 million / $18 million = 3.9x
Enterprise Value / Net Income (or the PE multiple net of cash) = $70 million / $15 million = 4.7x
Now, you must say with these multiples at these low levels the business must be either no growth, low margin, poorly managed, high annual capital expenditures, etc. But this is not the case as far as I can tell. The business grew revenue over 20% and net income by 160% in the first half of 2012 versus 2011. It has been profitable every quarter since 2010, it has generated cash from operations since 2009 every year (and grew net free cash flow from $10 million to $17 million over the past few years), it has gross margins near 70% in the first half of 2012 and the management team has done a great job of adapting to changing market conditions. So then you ask, why did it price so bad?
I will give you my thoughts here on why it priced poorly:
- It has customer concentration as its five largest customers account for 46% of the revenue. This is probably the primary risk I see, but certainly it is more than priced into the stock here.
- I think the fact that it is a semiconductor stock hurt this Company significantly on the IPO pricing as semis have been very weak of late (down near 10% since August) on macroeconomic concerns. I get these concerns overall, but again, at this price I think you are well compensated over the long term here.
- I think the fact that the end markets are in areas that don't appear to have explosive growth and/or have volatility hurt interest. While these are risks, management believes there is growth in many market segments as detailed in the IPO filing and has shown its ability to adapt to changing market conditions. For example, in fiscal year 2011, pocket video revenue represented 40% of total revenue. Smartphones and their ability to capture video significantly impacted this market, decreasing pocket video cameras' contribution to 15% of total revenue in fiscal year 2012 and just 1% of total revenue in the first half of fiscal year 2013. Yet despite losing 40% of their revenue from 2011 the Company has actually grown revenue on a net basis so that fiscal year 2013 looks like it will be the highest revenue year in the Company's history. To me, that is a sign of great management and an under the radar growth story (as in, there has been a lot of growth here it just gets masked by one market completely going away).
- It is a microcap which limits the investor base looking at the deal.
- The IPO market has been somewhat cold over the recent months to new issues with many pricing below expectations. Ironically, AMBA came public the same week at several high profile IPOs (WDAY, etc.) that did well out of the gate again possibly sucking interest away from AMBA.
Another tidbit I find interesting which is in the IPO filing is that they have recently had valuations done for the Company for option grants (see page 65/66 of IPO prospectus). The most recent was done July 10, 2012 and options were granted at $9.99 a share. That is 67% higher than the IPO price. It is not the be all end all of where this should be trading, but I bet most people don't even review these things in the filing. But do know that the valuation firm based at least part of that valuation on a discounted cash flow approach incorporating projections from the Company that are not public. It's just an incremental positive to me here.
In summary, I think AMBA, while not being the sexiest company from a high level perspective becomes pretty sexy from a valuation perspective as $6. With the low float, I can certainly see a case for this making a run to $10 if the third quarter results put this on the map. That is certainly possible as the third quarter is the best quarter of the year for this company. And if the results are only OK, I still can't see a ton of downside at this price. I see this as an opportunity for investors to take advantage of an unfortunately timed IPO. I am long.
Additional disclosure: I am long AMBA.